Why China Pays Over the Odds for Medicines

China has a drug problem. While most Western countries spend 10-12 percent of their health care budget on medicines, in China it is well over 40 percent, a disparity that goes to the heart of Beijing's crackdown on the industry.

A promise this week by GlaxoSmithKline (GSK) to make its drugs more affordable in China in the wake of a bribery scandal is an important lever Chinese authorities may now use to start redressing the balance.

Britain's biggest drugmaker has given no details on the size of the price cuts it will consider, but an examination of its discounts in other emerging markets suggests there may be scope for reductions for some medicines of a third or more. Other pharmaceutical firms might have to follow suit.

"Four executives were arrested, the company itself will probably be fined top to bottom, and they are having to cut prices," said one veteran industry executive in China, who declined to be identified.

"That'll send a signal to other players in the industry, and prices should come down."

Chinese police have detained four Chinese GSK executives in connection with allegations the drugmaker funneled up to 3 billion yuan ($489 million) to travel agencies to facilitate bribes to doctors and officials to boost sales and raise the price of its drugs.

GSK has said some Chinese executives appeared to have broken the law, but Chief Executive Andrew Witty said on Wednesday that head office had no knowledge of the alleged wrongdoing.

None of GSK's competitors in China has publicly said they would cut prices, and major pharmaceutical companies reached by Reuters have so far declined to comment.

But a precedent was set earlier this month when Nestle led other foreign milk powder makers in cutting prices in China after Beijing launched an investigation into possible price-fixing and anti-competitive behavior in that sector.

Around the same time, the powerful National Development and Reform Commission said it was examining pricing by 60 local and international pharmaceutical companies.

"The Chinese government never does anything without a reason. China could be using these investigations partly to clean house and to also drive prices down," said Philip Urofsky at law firm Shearman & Sterling, who previously worked at the U.S. Department of Justice on cases involving the Foreign Corrupt Practices Act.

Big premium for foreign medicine

Data from the World Health Organization (WHO) and other groups shows how China's drugs market has been thrown out of kilter by a system that effectively encourages public hospitals to prescribe large amounts of expensive medicine to earn revenue, given cuts in government subsidies over 30 years.

"In China, a very high proportion of health expenditure is spent on medicines, which reflects both over-consumption and high prices," said Hans Hogerzeil, a professor of global health at the University of Groningen and a former WHO director of medicines policy.

As in many emerging markets, there is strong demand in China for Western drugs, whose brands offer quality assurance in an environment where patients often worry over sub-standard or counterfeit treatments. As such, they can command hefty price premiums, even though they are no longer protected by patents.

Just how big a premium is revealed in data collected by Dutch-based Health Action International (HAI), a non-profit group focused on access to medicines.

HAI found that in China's Shaanxi province last year, prices charged for drugs made by the original Western drug company in both the public and private sectors were about 11 times the international reference price as calculated by the U.S.-based independent group Management Sciences for Health.

Exact comparisons with other markets are difficult, but a separate survey of prices in New Delhi, India, found the prices patients paid in the private sector for originator brands were much less at under five times the reference level.

China's government has also faced criticism that some drug prices are higher than in South Korea and Taiwan, both developed economies.

"You have to question why the Chinese government is buying high-priced originator brands for off-patent medicines. It's clear they could treat many more patients, without any increase in expenditure, if they only procured lower-priced, quality-assured generics," said Margaret Ewen, coordinator for global pricing at HAI.

GSK finds cheaper products sell more

GSK has a record of cutting prices in emerging markets.

In Indonesia, for example, GSK has halved the price of its top-selling inhaled lung drug Seretide, also known as Advair, and its antibiotic Augmentin was slashed by 50 percent in Brazil in 2010.

Newer drugs have seen price reductions, too, with Avodart for prostate enlargement cut by a third in Russia and a similar discount seen for cancer treatment Tykerb in India.

All these price cuts were made in the expectation that cheaper products would sell better — a strategy that GSK says has paid off in these cases.

Witty said on Wednesday that tiered pricing "may well be important" in China.

But he questioned if other big drugmakers would immediately follow because they all sold different medicines in China and might not be directly competing with any that GSK reprices.

Many international health experts would welcome tiered pricing as a way to counter pressures in the Chinese healthcare system, where hospitals get 40 percent of their income from prescribing drugs, giving doctors an incentive to use costly products and creating a fertile seedbed for corruption.

The most recent edition of the WHO's World Medicines Situation report, issued in 2011, said that in China "even in the most basic primary care level institutions, patients are frequently provided with unnecessary and expensive drugs."

As a result, medicines account for nearly half, or 43 percent, of China's total health expenditure, the WHO said.